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How to Spot a Market Bottom

December 03, 2008 – by Richard Band

I’ll be honest with you. I never dreamed, in my spookiest nightmares, that the financial markets would seize up the way they have recently.

I cut my teeth as an investor during the disastrous bear market of 1973-74, when inflation was running in double digits and the President of the United States resigned under threat of impeachment.

Yet the rout we saw in just the first half of October of this year surpassed even the carnage of those long-ago days.

Recall: In late September, the stock market was already scraping its low for the year. Never, in the past century, has a market so close to its lows plummeted another 26% (as measured by the Standard & Poor’s 500 index) in just two weeks.

Many overseas bourses sustained even greater damage. At the October nadir, Russia had skidded 72% in dollar terms from its all-time high, set just five months before. European stocks nosedived 46% from their 2007 summit, even before factoring in the recent decline in the euro currency. Japan, never in the pink of health, lost more than half its peak 2007 value.

In effect, the markets have issued a wakeup call, loud as a jet engine, not only to America but also to the whole world. Too many people have borrowed more than they can pay back.

Now that the easy money has dried up, we’re finding out who loses a seat at the party — through bankruptcy, foreclosure and fire sales of distressed assets.

Peering Into the Future

That’s what we’ve endured, but the real questions are…

Where are we headed, and what should you as an investor be doing right now? (See also: "Making Sense of This Crazy Market.")

Given the severity of the market selloff, it’s prudent to assume that a recovery for stocks (and, afterward, the economy) will take longer than we might have expected as recently as a couple of months ago.

Best case, the market could complete its bottoming process soon. But we’ll need to monitor the action day by day, which is what I do for my Proftiable Investing members in my subscriber-only blog that I update frequently. Click here to join today and receive immediate access to my very latest advice.

To get a real, sustainable bottom, we’ll be looking for evidence in the weeks ahead that buyers are growing braver and sellers less bold.

Trading volume in advancing stocks should run well ahead of that in decliners — not just for a day or two, but for at least two weeks at a stretch. The tribe of stocks touching new 52-week lows should diminish substantially.

Gold prices, spreads between T-bill yields and bank rates, and other "fear" indicators should retreat. Otherwise, I’ll recommend that my readers take additional defensive measures beyond the cash raising we executed during the summer.

Meanwhile, if your portfolio is already close to my recommended weighting of 62% stocks and 38% fixed income, you’re playing it just about right for now. With your cash and bonds, you’ve already built a considerable degree of safety into your investments. (See also: "5 Top Income Stocks to Buy Now.")

What To Do Now

It’s smart to upgrade your portfolio whenever Mr. Market gives you a chance.

Take advantage of strong up days to weed out stocks and mutual funds that no longer fit into your overall plan (and to raise cash if you’re overweighted in equities).

Is anything worth buying in here?

Absolutely. Stick with companies that boast impregnable balance sheets and healthy earnings prospects. International Business Machines (IBM) certainly meets those requirements. IBM’s third-quarter profits leaped 22%, defying naysayers who expected the technology titan to miss forecasts.

At 8X trailing profits, Big Blue is selling at its lowest in 13 years, when the company was in the early stages of its historic makeover into a services-oriented organization. Debt is modest; indeed, IBM is one of the few corporations strong enough to borrow money at reasonable rates, even in today’s climate. I’m projecting a 30%–40% total return within a year.

Besides cash-rich technology issues like Beamer, I’m attracted to the nation’s prime defense contractors. The world’s precarious security situation makes it all but certain that the U.S. government will continue to modernize our weapons systems — a process that takes big bucks.

You’ll hardly go wrong with any of the leading defense contractors, but I especially like one that I’ve recommended to my readers.

This defense stalwart is selling at a trifling 9X earnings, about 50% below the stock’s P/E five years ago. Such a huge discount gives you a margin of safety in the event of a slowdown in defense spending.

Moreover, this company has taken care to beef up its balance sheet during the recent prosperous years. Since 1999, the company has slashed its long-term debt by more than 70% — an astonishing feat. Cash balances stand at a record $3 billion.

If there’s such a thing as a recession-proof business, this is it. I’m projecting 30% (or more) returns over the next 12 months.

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